Property taxes seem straightforward: you own the property, you pay taxes annually. But there's a hidden trap that blindsides many CRE investors, especially in states with homestead exemptions or value-lock laws like California's Proposition 13. When you buy a property, the local assessor typically revalues it for tax purposes. That reassessment can trigger a 20–50% increase in annual taxes within 12 months of acquisition. If you underwrite assuming the seller's historical tax bill continues, you'll have a nasty surprise in year 2: suddenly your NOI drops 10–20%, your DSCR declines below acceptable levels, and your IRR projections are broken. Understanding tax reassessment and modeling it correctly is critical to accurate underwriting.
How Property Tax Assessments Work
Property taxes are assessed by local governments based on property value. Tax liability equals assessed value times tax rate (millage rate). Example: a 5 million dollar apartment building in Colorado with assessed value 4.25 million dollars at mill rate 0.85% equals annual tax liability of 36,125 dollars. Assessment frequency varies by state; most states reassess annually. Some states reassess only when property changes hands (sale is reassessment trigger).
Proposition 13 and Value-Lock Laws
California's Proposition 13 (and similar laws in 17+ states) is the primary driver of assessment-related surprises. Prop 13 limits tax increases to 2% per year. If property is assessed at value X in year 1, year 2 assessment equals X times 1.02, year 3 equals X times 1.0404. When property changes hands, it's reassessed to current market value. Result: old-owner properties have very low assessed values (locked in at old purchase price); new owners see huge tax jumps.
Real example: A California apartment building purchased in 1995 for 3 million dollars. Assessed value locked in at 3 million dollars. Due to 2% annual increases, 2024 assessed value is only 4.85 million dollars. Annual taxes at 0.76% rate: 37,000 dollars. You buy building for current market value of 8 million dollars. Upon reassessment, new assessed value is 8 million dollars. Annual taxes: 61,000 dollars. Tax increase: 24,000 dollars (65% jump) in year 2 when reassessment occurs.
Modeling Tax Risk in Underwriting
Conservative approach: Assume taxes increase to 1.0–1.2% of purchase price in year 2. Why? Assessed value post-reassessment is typically close to recent sales price (your purchase price). Local mill rates vary (0.75–2.0%+ depending on state and county). Conservative: assume 1.0–1.2% equals taxes of 10–12,000 dollars per 1 million dollars of purchase price.
Real impact example: You acquire 50 million dollar apartment building. Current seller taxes: 250,000 dollars annually (0.5% assessed value divided by 2, reflecting Prop 13 lock-in over 25+ years). You model year 2 taxes at 1.0% of 50 million dollars equals 500,000 dollars (assumed after reassessment). Tax increase: 250,000 dollars (100% jump). Impact on NOI: if year 1 NOI is 4 million dollars, year 2 NOI becomes 3.75 million dollars after tax increase. DSCR with 3.5 million dollar debt service: year 1 DSCR 1.14x (marginal); year 2 DSCR 1.07x (distressed). This reassessment-driven DSCR decline can trigger lender covenant violations or refinance difficulty.
How to Underwrite Tax Increases
Step 1: Get seller's current annual property tax bill. Verify the assessed value and mill rate from county assessor website. Calculate implied assessment year (assess value / mill rate tells you when property was last assessed).
Step 2: Estimate year 2 tax bill. New assessed value will be close to your purchase price (or appraisal if lower). New tax liability equals new assessed value times mill rate. Conservative: assume mill rate is at median for your county (check county assessor data).
Step 3: Model in your underwriting. Year 1 operating expenses include seller's historical tax bill. Year 2 operating expenses jump to new assessed value tax liability. Impact year 2 NOI and DSCR. If impact is severe (DSCR drops below 1.20x or loan covenant is violated), renegotiate purchase price downward or request seller concession to cover tax increase risk.
Bottom line: Property tax reassessments are a major blind spot in CRE underwriting. In Prop 13 states, always assume 30–50% tax increase post-acquisition. Model conservatively: taxes will increase to 1.0–1.2% of purchase price in year 2. If impact materially reduces DSCR or violates loan covenants, renegotiate or walk away. Tax increases directly reduce NOI and impact your deal returns; factor this into underwriting from day one.